Even though the relationship between global current-account imbalances and the recent financial crisis is at best a tenuous one, the issue of imbalances as a source of global instability and a threat to the sustainability of recovery remains alive and kicking (Blanchard and Milesi-Ferretti 2009). Concerns about global imbalances have led to some quite far-reaching conclusions, including a proposal for imposing quantitative targets on the current-account balances.1 In this column we place Germany in international perspective and find that structural causes explain very little of the emergence of imbalances prior to the recent crisis, and even with regards to the levels of the current account, the links with the structural measures are rather imprecise.
The emergence of imbalances across the world coincided with the global exuberance preceding the crisis. Despite the evident cyclical forces driving the imbalances, much policy focus has been on possible structural causes and remedies. But what is the link between structural policies and the current account?
The literature (Chinn and Prasad 2003, Abiad et al. 2009, Jaumotte and Sodsriwiboon 2010) commonly finds that current-account balances are, to a large extent, driven by such “fundamentals” as per capita income, fiscal stance, demographics, oil prices, the initial net foreign assets position, and the degree of financial integration – the latter particularly important in fast-growing countries. A recent study (Ivanova 2011) confirms these findings with the model explaining about 40% of the variation in current-account balances over the past 35 years. However, the residuals from the current-account regression largely mirror the imbalances. Hence, the “fundamentals” did not evolve to generate the imbalances. Using this as a baseline, the study concludes that the emergence of the pre-crisis imbalances was substantially a cyclical phenomenon.
What about structural factors that are typically not included in such regressions? The answer to that is also straightforward. Structural factors such as regulation, taxation, the level of minimum wage, and unemployment benefits on their own cannot explain the emergence of imbalances either. These factors either did not change significantly over this short time horizon or changed in the same direction for surplus and deficit countries. They may have shaped the response of individual countries to the global shocks but empirical evidence on this is patchy and inconclusive.
However, while structural factors cannot account for the emergence of imbalances, they can help partly explain the long-standing differences in the levels of the current accounts across countries. Even these findings need to be qualified as they are not robust across country samples, with some commonly recommended reforms increasing and some reducing the current-account balance. With these caveats, the empirical results suggest that lower business taxation, credit market regulation, and unemployment benefits can reduce the current-account surplus. Lower minimum wage and employment protection, often recommended for making the labour market “more flexible”, are associated with larger current-account surpluses.
Hence, the empirical evidence points to select structural measures rather than a broad and diffuse structural reforms’ package for addressing imbalances. For Germany, the results suggest that lower taxes on businesses, further reduction in the gross unemployment replacement rate, and a smaller public share in the banking system could reduce the surplus, albeit only moderately. Despite a comprehensive reform of the corporate income tax in 2008, the combined federal and local corporate tax rates in Germany remain above the OECD average. German unemployment benefits also remain rather generous. Public-sector banks occupy an important place in the German system, more so than in other advanced economies. These banks have implicit government backing and low profitability. The package of measures, which includes a scaling down of public provisioning of banking services, a reduction in unemployment benefits towards the OECD average, and reduction and simplification in business taxes to move Germany to the US level could reduce the surplus by about 1¼% of GDP.
A parallel concern has been raised about the growth in intra-European imbalances. The concept, however, of imbalances within a region is analytically dubious. Germany’s large and growing trade surplus indeed coincided with larger deficits in other European countries. But these outcomes also reflect European trade with the rest of the world. In particular, the shifts in intra-European balances reflect to a large degree the changing relationships with China. Germany has retained dominance in market segments in which China is still a modest player; other European countries have, to varying degrees, had to face direct competition with China, as also with low-wage Eastern Europe.
Through its advantage in a large number of specialised products, in particular capital goods and consumer durables, Germany, unlike many other advanced countries, was able to maintain its world market shares in the past decade. German exports have remained largely insulated from Asian and lower-wage European competition. Despite its strong export performance to China and other growing Asian economies, the German trade deficit with China has been widening. This, in part, reflects the tilt in Germany’s imports towards products produced most cost-effectively by China and away from European sources. Thus, while Germany has stood its ground in the face of global competition, other European economies have not been so successful. While this phenomenon manifests as increased intra-European imbalances, the outcome is not the consequence of direct trade relationships between the surplus and deficit countries.
The key to a sustainable moderation of Germany’s current-account surplus lies in raising incentives to invest. German corporate investment has remained low compared to European peers – even when accounting for foreign direct investment outflows. Rebalancing public finances to increase labour force participation and investment, securing greater efficiency and stability of the financial sector, and pursuing a broader growth agenda, including tax, education, and innovation policies, would increase permanent incomes and thereby raise domestic consumption and investment. Hence, while German surpluses can be expected to moderate as the global economies normalise after their pre-crisis froth and the disruption of the Great Recession, an ambitious reform agenda will ensure sustainable rebalancing.
The views expressed in this article are those of the author and do not necessarily represent those of the IMF, IMF policy, or the Executive Board of Directors.
This and companion columns on growth and fiscal spillovers and structural contributors to the current-account surplus form background work for the IMF’s 2011 Article IV Consultation with Germany, which was concluded on 6 July 2011. The staff report is available online here.
Abiad, A, D Leigh, and A Mody (2009), “Finance and Convergence”, Economic Policy, April:241-305.
Blanchard, O and GM Milesi-Ferretti (2009), “Global Imbalances: In Midstream?” IMF Staff Position Note 09/29.
Chinn, MD and E Prasad (2003), “Medium-term Determinants of Current Accounts in Industrial and Developing Countries: An Empirical Exploration”, Journal of International Economics, 59.
Ivanova, A (2011), “Current Account Imbalances: Can Structural Policies Make a Difference?”, IMF Working Paper (forthcoming).
Jaumotte, F and P Sodsriwiboon (2010), “Current Account Imbalances in the Southern Euro Area”, IMF Working Paper 10/139.
1 A proposal by the US Treasury Secretary Timothy F. Geithner to the meeting of G20 ministers in South Korea in 2010.